BE 530 Page 1 of 5 Lecture 11-Chapter 14 Game Theory: Chapter Review Gametheoryis the study of how people behave in strategic situations. Strategic situations are when decision makers must consider how others might respond to their actions. The prisoners’ dilemmais a particular "game" between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial. The game applies to oligopoly because oligopolistic firms would always be better off to cooperate yet they often do not. An example of a prisoners’ dilemma is the following: Two criminals are captured. If one confesses and the other does not, the confessor goes free while the other receives a long sentence. If both confess they each receive an intermediate term. If neither confess, they each receive a very short term. If the two could cooperate, the best strategy is for each to keep quiet. However, since they cannot guarantee cooperation after they are caught, the best strategy for each is to confess. That is, confessing is a dominant strategy—a strategy that is best for a player in a game regardless of the strategies chosen by the other players. The prisoners’ dilemma applies to oligopoly in the following manner: Two oligopolists are better off if they cooperate by keeping production low and sharing the monopoly profits. However, after the agreement is made, the dominant strategy for each is to cheat and produce more than they agreed to produce to enhance their individual profits. The result is that profits fall for both. Self-interest makes it difficult to maintain cooperation. The prisoners’ dilemma applies to: •Arms races: Each country prefers to live in a safe world but the dominant strategy is to increase armaments and the world is less safe.

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